The short answer
You can accept it, but any cash you keep through closing is taxable boot rather than deferred gain. The regulation takes a deferred exchange outside section 1031 to the extent you receive money as part of the consideration, and counts money as received the moment you have it or its economic benefit (26 CFR 1.1031(k)-1(f)(1) and (2)). An option payment credited to the price when the buyer exercises, or a deposit released to you early, is that money unless it is sitting with the closing agent or intermediary before the deed transfers.
At a glance
| Rule | Money received as part of the consideration is outside 1031, Reg. 1.1031(k)-1(f)(1) |
|---|---|
| Timing test | Receipt occurs when you get the money or its economic benefit, Reg. 1.1031(k)-1(f)(2) |
| Exercised option | Option money joins the amount realized on the sale (Rev. Rul. 58-234) |
| Lapsed option | Ordinary income to the grantor when the option dies, Reg. 1.1234-1(b); no exchange occurs |
| Cure | Deposit the cash with the closing agent or QI before closing (Asset Preservation) |
| Taxable amount | Boot is taxed up to your realized gain; it does not void the rest of the exchange |
Cash you hold at closing is boot, and it is taxed even when the rest of the exchange succeeds
The regulation says a transfer in a deferred exchange is not within section 1031 if, as part of the consideration, the taxpayer receives money, and that you are in actual receipt when you actually receive the money or receive its economic benefit (26 CFR 1.1031(k)-1(f)(1) and (2)). Receiving cash in March and closing in June does not launder it; it is still part of what the buyer paid you.
The consequence is partial, not total. Boot is recognized up to your realized gain and the balance still defers, so in a hypothetical sale with $400,000 of gain a seller who keeps a $50,000 option payment recognizes $50,000 and defers $350,000; What is boot in a 1031 exchange? explains the mechanics and Is boot taxed as recapture or capital gain first? explains the rate.
A non-refundable option payment is taxable either way: sale price if exercised, ordinary income if not
Option money follows the option. If the buyer exercises, the amount received for granting the option is included, together with the option price, in the amount realized on the sale; Rev. Rul. 58-234 states that rule for call options, and it means the option payment is part of the consideration the regulation counts as boot. If the buyer walks, there is no sale to exchange and the payment is ordinary income to you as grantor in the year the option lapses (26 CFR 1.1234-1(b)).
Labelling the payment 'separate consideration for the option' does not change the analysis once it is credited against the price at closing, because the credit is the economic benefit the regulation looks for. The only structures that keep it out of boot are ones in which you never hold the money before the exchange closes.
Early release of the buyer's deposit is the same cash under a different name
Asset Preservation's deposit guidance draws the line: if you enter the exchange agreement before closing and deposit the earnest money with the intermediary or the closing agent before the closing occurs, receiving the deposit is not receipt of sale proceeds, but if you keep the deposit through the closing it constitutes boot, taxable to the extent there is a capital gain.
A buyer's request to release the deposit to you when contingencies clear is therefore a request that you take boot. Say yes to the release but direct it to escrow or the intermediary's account, where it is disbursed with the rest of the proceeds at closing.
Ask why the buyer wants the release at all. A buyer who needs you to hold the money has a financing or commitment problem the release will not solve, and the tax cost of solving it lands on you.
Three structures that keep pre-closing cash out of your hands
Each of these gives the buyer the commitment it wants without putting money in your account before the deed transfers. Confirm the wording with your attorney, because the contract terms decide who can draw the funds.
- Option money or deposit held by the title company under joint instructions, credited to the price at closing and paid to the intermediary with the proceeds
- Option fee paid after the exchange documents are signed and wired to the intermediary's qualified escrow account, so it sits under the (g)(6) restrictions from the start
- A higher purchase price or a shorter option period in place of cash now, so the buyer's commitment shows up at closing as proceeds to the intermediary
- If you truly want spendable cash before closing, treat it as intentional boot, estimate the tax with your CPA and take only that amount
Already deposited the buyer's money in your own account? Move it before the deed transfers
Asset Preservation's rule turns on where the deposit sits at closing, not where it went first: a deposit delivered to the intermediary or closing agent before the closing occurs is not sale proceeds. Wire the full amount to escrow or to the intermediary's exchange account now, keep the bank record, and tell the closing agent so the settlement statement shows the deposit as held in escrow rather than paid to seller.
Do this after the exchange agreement is signed, since the regulation measures receipt against the safe harbor and there is no safe harbor until the agreement exists. If part of the deposit has already been spent, the amount you cannot restore before closing is boot, and Do I have to reinvest the whole sale price, or just my gain? shows how it changes the reinvestment math.
Red flags in any buyer proposal that pays you before closing
Run every creative term past the intermediary before you sign. It will tell you whether the money can be routed to its account, and your CPA or attorney can price the tax if it cannot.
- Cash to you now that is 'credited to the price later'; the credit is the economic benefit the regulation counts
- A deposit that becomes non-refundable and payable to you when contingencies expire
- Rent under a lease-option credited against the purchase price rather than kept as rent
- Seller financing where the buyer prepays part of the note before closing; Can I carry a note for my buyer? covers notes
- Any payment routed through your attorney or agent, since receipt by your agent is receipt by you (26 CFR 1.1031(k)-1(f)(2))
Related questions
Is rent under a lease-option boot?
Rent that stays rent is ordinary rental income, not consideration for the sale. Rent credited against the purchase price becomes part of the price you were paid before closing, which is the boot problem this page describes.
Does a small option payment blow the whole exchange?
No. It is taxable up to your gain and the rest of the exchange proceeds normally, as long as the intermediary receives the remaining proceeds and every other rule is met.
What if the option payment and the closing fall in different tax years?
The regulation looks at what you received as consideration for the transfer, so an option payment kept in year one and credited at a year-two closing is still boot on that exchange. Which year it is taxed in is a question for your CPA, and Selling late in the year explains the installment-method wrinkle.
Can I refund the option payment at closing and avoid boot?
If the money is returned to the buyer or delivered to escrow before the deed transfers, you no longer hold it at closing, which is the test Asset Preservation applies to deposits. Document the transfer and have the settlement statement reflect it.
Does a deposit that goes non-refundable change anything if escrow still holds it?
No. A deposit that goes hard but stays in escrow until closing is disbursed to the intermediary with the proceeds; only a deposit disbursed to you before closing is boot.
Sources
Checked against these publications on September 19, 2026. Rules and figures change; confirm the current version with your CPA or attorney before you act. This page is general information, not tax or legal advice.
- 26 CFR § 1.1031(k)-1, Treatment of deferred exchanges (constructive receipt, qualified escrow, qualified intermediary, (g)(6) restrictions)
- 26 CFR § 1.1234-1(b), Gain to the grantor of an option on its lapse is ordinary income
- Rev. Rul. 58-234 (option premium: ordinary income on lapse; included in amount realized on exercise)
- Asset Preservation, Inc.: Deposits in an exchange (deposit kept through closing is boot)
- IPX1031: 1031 constructive receipt
- Asset Preservation, Inc.: Constructive receipt (Reg. (f)(2) definition)